Financial Services Law

Manatt Adds Leading Payments, Regulatory and Consumer Financial Services Lawyer

Manatt announced this week that Anita L. Boomstein has joined the New York office as chair of the firm's global payments practice. Boomstein joins the firm from Hughes Hubbard and Reed LLP, where she was a partner in the banking and financial services practice.

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Comments Reveal Mixed Reaction to OCC Fintech Charter

As the comment period ended on the Office of the Comptroller of the Currency's (OCC) proposal to establish a fintech charter, stakeholders weighed in on both sides of the idea.

What happened

The OCC announced in December that it will consider applications from fintech companies seeking national bank charters, enabling the company to originate loans and access the payment system directly without relying on third-party banks. An OCC charter would further allow fintech companies to operate across the country without the need for a separate license in each state where customers are located.

With the comment period closing on the proposal, stakeholders hurried to meet the deadline and weigh in on the OCC's plan. Some members of the industry were outspoken in their criticism, such as New York Department of Financial Services (DFS) Superintendent Maria T. Vullo, who said her agency opposes "the imposition of an entirely new regulatory scheme on an already fully functional and deeply rooted state regulatory landscape that is working."

"Technology is not new to financial services and thus using the term 'fintech' to potentially sweep all nonbank financial services companies not authorized by the National Bank Act into a new regulatory regime is highly problematic," the DFS wrote in its comment letter. States already regulate nonbank financial services companies and the creation of a special purpose charter threatens to undermine important consumer protections under state law, the regulator argued, such as the possibility of lenders skirting state usury laws.

Further, nonbank financial institutions present unique risks that are different from the entities the OCC has experience regulating, Vullo wrote. While the DFS supports efforts to encourage responsible innovation in the financial services industry, these efforts "should not be used as an excuse to widely extend and expand the OCC's jurisdiction, beyond the National Bank Act's reach, to types of entities that the OCC has not previously regulated."

The creation of a national charter is likely to stifle—rather than encourage—innovation because it would provide "an avenue for larger, more dominant firms to control the development of technology solutions in the financial services industry," according to the DFS letter. "The ability to start and license a business through a state licensing regime is the appropriate way to foster the development of technological enhancements and encourage small businesses."

Calling the proposed fintech charter "a complicated, problematic, new regulatory regime," the DFS opposed the plan.

Others had a more positive take on the proposal. The American Bankers Association (ABA) "supports the OCC's intent to consider special purpose charter applications from fintech companies as long as existing rules and oversight are applied consistent with those for any national bank," the group wrote. "Any such charter option must be implemented thoughtfully to ensure that the policy determinations underlying our bank regulatory framework are maintained, including the separation of banking and commerce. This means applicable rules are applied evenly and fairly across all national bank charters, and the OCC performs effective oversight to assure safe and sound operation and consumer protection."

Viewing the OCC's proposal as "an opportunity to further bring financial technology into the banking system," the ABA said that three aspects must be required of any newly chartered member of the national banking system: strong and consistent regulation, effective oversight, and charter responsibilities.

The Financial Services Roundtable (FSR) also threw its support behind the proposal. "We commend the OCC for its development of this proposal," the group wrote. "Just as the financial industry needs to evolve with technology and changing customer preferences, so, too, must financial regulations and the regulators themselves. A special purpose national bank charter for Fintech companies would be an important step in that process."

Technological innovation is not limited to nonbank entities, the FSR noted, however. "National banks are actively engaged in the digital transformation and, as such, their regulatory and supervisory treatment must be holistically considered and reexamined in any update of regulatory standards intended to address innovation and Fintech," the group suggested, emphasizing the importance of parity among the charters and the need to avoid a "two-tiered national banking system under which special purpose [f]intech banks are subject to compromised supervisory standards."

Charting something of a middle course, the Consumer Bankers Association (CBA) requested greater clarity from the OCC about the regulatory and supervisory framework that will be applied to fintech companies, withholding its support until more details have been provided. "Although CBA is not opposed to expanding the scope of companies eligible for a national bank charter, we believe fundamentally important decisions such as these should be based on well-developed policy positions that have weighed the risks and rewards to all stakeholders in the banking industry," the group wrote.

Similarly, the Independent Community Bankers of America (ICBA) said the OCC proposal "raises more questions than it answers," urging the agency to collaborate with other bank regulators and issue rules under the Administrative Procedure Act, subject to notice and comment. The group also stressed the need "to ensure a level playing field," with fintech chartered institutions subject to the same supervision and regulation as community banks.

To read the comment letter from DFS, click here.

To read the ABA comment, click here.

To read the FSR comment, click here.

To read the CBA letter, click here.

To read the ICBA comment, click here.

Why it matters

Comments on the OCC's proposal to create a special purpose national bank charter for fintech companies ran the gamut from staunch opposition to possible acceptance with some caveats to support and commendations for the regulator. Challenges by state regulators to the OCC proposal are of particular concern since cooperation between federal and state agencies in financial services regulation is critical to the overall health of the industry. With the comment period ended, the ball is now in the OCC's court.

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Seventh Circuit: Bank May Challenge CAMELS Rating

A bank may challenge the rating it received from the Federal Deposit Insurance Corporation (FDIC) under the CAMELS system, the U.S. Court of Appeals for the Seventh Circuit determined, because while the agency has discretion to set appropriate levels of capital for each institution, it does not necessarily mean that the rating as a whole is committed to agency discretion.

What happened

The FDIC conducted a full-scope on-site examination of Builders Bank, insured and regulated by the FDIC, in June 2015. The regulator assigned the bank a rating of 4 under the Uniform Financial Institution Ratings System, commonly referred to as a CAMELS rating because of the six components: capital, asset quality, management, earnings, liquidity and sensitivity. The highest rating is 1 and the lowest is 5.

The bank filed suit against the FDIC under the Administrative Procedure Act (APA), arguing that its rating should have been a 3 and that the lower rating was arbitrary and capricious. A federal district court granted the FDIC's motion to dismiss, holding that the assignment of ratings is committed to agency discretion by law.

Builders appealed. The Seventh Circuit first engaged in a discussion of whether the question was a matter of jurisdiction or another doctrine that foreclosed judicial review, noting that the FDIC bypassed two procedural reasons why it might prevail. First, APA review is normally limited to final agency actions and assignment of a CAMELS rating "does not appear to be a final decision," the panel said. Second, the bank failed to take advantage of the opportunity to have the FDIC's Supervision Appeals Review Committee review the rating before filing suit, the court noted.

But the court ultimately sidestepped the jurisdictional issue to consider the matter of discretion. The FDIC argued that the CAMELS rating was not reviewable because it has the discretion to set appropriate levels of capital. Even accepting this position, the Seventh Circuit noted that capital was only one of six components to the overall rating.

"Each of the six factors is rated separately on a scale of 1 to 5, and the rating as a whole aggregates those six factors," the panel wrote. "Suppose the FDIC's team of examiners were to conclude that the Bank had adequate capital deserving a rating of 1 but that other components were unfavorable, leading to an overall rating of 4. The examiners may be right or wrong about those other issues, but a district court could ask whether the FDIC's final rating was arbitrary, or supported by substantial evidence, without making any inroad on the agency's discretion to evaluate a bank's capital adequacy."

That precise situation occurred in a case from the U.S. Court of Appeals for the Tenth Circuit, where the court in Frontier State Bank v. FDIC reviewed management, liquidity and interest-rate-sensitivity while concluding that capital adequacy was unreviewable. "If those subjects could be reviewed there, notwithstanding the Tenth Circuit's conclusion that capital adequacy is within the FDIC's discretion, they can be reviewed in this litigation as well," the court said.

It might even be possible to review the capital rating itself without infringing on the FDIC's discretion, the Seventh Circuit added. "Suppose the FDIC were to decide that Builders Bank needs $5 million in net capital in order to operate safely but has only $4 million," the court said. Although the $5 million is beyond judicial questioning, "the statute does not insulate the agency's math. If the Bank were to contend that the examiners found that it fell short of $5 million because they had mistakenly treated a $1 million asset as a $1 million liability, turning $6 million of net capital into $4 million by error, a court would not impinge on the statutory discretion by insisting that assets go in one column of the balance sheet and liabilities in the other."

For its part, Builders told the court that it took the FDIC's capital requirement as a given and was only challenging its rating on the other five factors. While the regulator countered that the bank was simply trying to disguise a challenge to a capital decision, the district court did not decide this dispute, the Seventh Circuit said, remanding the question.

"All we hold today is that the presence of capital as one of six components in a CAMELS rating does not necessarily mean that the rating as a whole is committed to agency discretion for purposes of the [APA]," the court wrote.

To read the decision in Builders Bank v. Federal Deposit Insurance Corporation, click here.

Why it matters

The Seventh Circuit decision left open the door for banks to challenge five of the six components in a CAMELS rating: asset quality, management, earnings, liquidity and sensitivity. The court remanded the case to the district court to consider whether one or more of these components may be committed to agency discretion or if they can be challenged by a bank, providing support for the bank's position in a citation to a Tenth Circuit case where a federal panel permitted judicial review of such factors.

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Supreme Court Considers New York's Surcharge Law

The Supreme Court of the United States recently heard an oral argument concerning New York's surcharge law, addressing whether the statute—which prohibits the imposition of surcharges on customers who pay with credit cards but permits discounts for those who pay in cash—constitutes an infringement of merchants' First Amendment rights.

What happened

In reaction to the expiration of provisions of the Truth in Lending Act (TILA) that prohibited credit card surcharges, the New York legislature enacted Section 518 of the General Business Law, which states: "No seller in any sales transaction may impose a surcharge on a holder who elects to use a credit card in lieu of payment by cash, check or similar means. Any seller who violates the provisions of this section shall be guilty of a misdemeanor punishable by a fine not to exceed five hundred dollars or a term of imprisonment up to one year, or both." Merchants are still permitted to offer cash discounts.

New York's law took effect in 1984 along with similar statutes in ten other states: California, Colorado, Connecticut, Florida, Kansas, Maine, Massachusetts, Minnesota, Oklahoma, and Texas. Enforcement of the New York law was limited over the years, in part due to the standard provisions in credit card issuers' contracts that prohibited the use of surcharges.

But over the last decade, as sellers began challenging these provisions, issuers have dropped their contractual prohibitions on credit card surcharges. In response, a group of New York businesses and their owners and managers filed suit challenging Section 518 in 2013. The plaintiffs claimed the law violated their First Amendment free speech rights, requesting it be declared unconstitutional.

A federal district court judge sided with the merchants and struck down the law but a panel of the U.S. Court of Appeals for the Second Circuit reversed. Section 518 does not regulate speech, the court held—it regulates conduct. Prices, although necessarily communicated through language, do not rank as "speech" within the meaning of the First Amendment.

"By its terms, Section 518 does not prohibit sellers from referring to credit-cash price differentials as credit-card surcharges, or from engaging in advocacy related to credit-card surcharges; it simply prohibits imposing credit-card surcharges," the panel wrote. "Whether a seller is imposing a credit-card surcharge—in other words, whether it is doing what the statute, by its plain terms, prohibits—can be determined wholly without reference to the words that the seller uses to describe its pricing scheme."

However, other federal circuit courts reached different conclusions when considering surcharge laws, including the U.S. Court of Appeals for the Eleventh Circuit. Recognizing the split, the Supreme Court of the United States granted certiorari in the Second Circuit case.

At oral argument, the justices seemed skeptical when questioning the merchants' counsel. "I just don't see anything about speech in the statute," Justice Sonia Sotomayor commented, while Justice Stephen Breyer noted that the law appears to be a form of price regulation that states a merchant "can't charge a surcharge" for credit and is silent about any cash discount.

Responding to Justice Breyer, Deepak Gupta, counsel for the merchants, told the Court that state officials informed some of the merchants that they didn't need to change what they charged—instead, they needed to change what they told consumers. "That's not price regulation," Gupta said. "That's the regulation of how prices are communicated."

Justice Elena Kagan did not appear persuaded, commenting that the merchants placed a great deal of emphasis "on a few cases in which prosecutors describe the law in a certain way," but that the New York statute, "as written, doesn't really do any of the things that you are saying."

Indicating another path the Court could take, Justice Samuel Alito remarked that he was "uncomfortable" ruling on the constitutionality of a state law without the input of the state's highest court. "So why shouldn't we certify that question of interpretation to that court before we plunge into this First Amendment issue?" he asked. Gupta answered that the merchants had raised an as-applied constitutional challenge based on the application of the law to the plaintiffs.

Eric Feigin, arguing as amicus curiae on behalf of the United States, tracked Justice Alito's position to suggest that the Court remand the case to the Second Circuit "and allow for the New York Court of Appeals to have a definitive interpretation of the law, because there's clearly some dispute about what the New York law does."

Advocating on behalf of the New York Attorney General's Office, Steven Wu told the justices that the "plain text of New York's statute refers only to a pricing practice and not to any speech." Justice Kagan pointed out that the state's "enforcement history" seemed to be at odds with this argument while Justice Alito expressed concern that individual district attorneys could have different interpretations of the statute.

Justice Ruth Bader Ginsburg also pushed back on Wu's characterization of the law as "direct price regulation," noting that it "doesn't set any price at all. It lets the merchant set the price. And the question is how that price is described."

Considering various hypothetical pricing scenarios and how the state would view them, Justice Anthony Kennedy asked if the New York statute is too vague. Wu answered in the negative, stating that the law could withstand a vagueness challenge. He also indicated that a dual pricing system would be legal under the statute, although Justice Kagan replied that the Second Circuit had "abstained" from deciding that issue.

To read the transcript of the oral argument in Expressions Hair Design v. Schneiderman, click here.

Why it matters

A decision from the justices is expected later this term, with significant implications for retailers across the country and particularly those in states with surcharge laws, including California and New York.

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CFPB Hits Student Loan Servicer With Lawsuit

The Consumer Financial Protection Bureau (CFPB) has sued a major student loan servicer as detailed by the complaint filed in Pennsylvania federal court.

What happened

The CFPB's complaint alleges that the servicer created obstacles to student loan repayment in a multitude of ways that amounted to allegedly unfair, abusive and deceptive practices.

The CFPB alleges that the company failed to follow the directions of borrowers with regard to repayments, repeatedly misapplied or misallocated payments, made the same errors repeatedly and neglected to correct mistakes. According to the CFPB's complaint, the servicer allegedly steered borrowers toward paying more than they needed to on their loans, and guided borrowers into forbearance agreements in lieu of a new repayment plan. Under federal law, borrowers have the right to apply for a repayment plan with a lower monthly payment. Instead of informing consumers about this option, the CFPB says the servicer would suggest forbearance, where borrowers take a break from making payments but interest continues to accrue. Between January 2010 to March 2015, the company earned $4 billion in interest for borrowers enrolled in multiple, consecutive forbearances, the CFPB claims.

The servicer likewise allegedly failed to adequately inform borrowers in income-driven repayment plans about their obligation to recertify their income and family size on an annual basis. Many borrowers failed to renew their enrollment on time and lost their lower monthly payments as a result, the CFPB said, and this practice also allegedly led to losing other protections such as interest subsidies and progress toward loan forgiveness.

The complaint also alleges that borrowers seeking to release a co-signer from a loan faced obstacles and were confronted with allegedly deceptive information from the servicer. Although the servicer stated that a borrower could apply to release a co-signer after a certain number of consecutive, on-time payments were made, the CFPB alleges that the company reset the clock when a borrower prepaid a monthly installment.

Finally, the CFPB claimed that the servicer potentially harmed the credit of disabled veterans by misreporting to the credit reporting companies that severely and permanently disabled veterans who had their loans forgiven under the federal Total and Permanent Disability discharge program had instead defaulted on their loans.

The CFPB is purporting to enforce claims based on these alleged facts under its claimed authority to prosecute unfair, abusive or deceptive practices. The CFPB's complaint also includes a claim for violation of Regulation V in the servicer's credit reporting practices.

Why it matters

The CFPB has kept a close eye on student loans, publishing a report on the industry in 2015 that featured a framework for reform, followed up by a study in 2016 that found eight million borrowers are in default on more than $130 billion in student loans, a problem the CFPB perceives as exacerbated by what it views as poor loan servicing. "For years, [the servicer] failed consumers who counted on the company to help give them a fair chance to pay back their student loans," CFPB Director Richard Cordray said in a statement. "At every stage of repayment, [the servicer] chose to shortcut and deceive consumers to save on operating costs. Too many borrowers paid more for their loans because [the servicer] illegally cheated them and today's action seeks to hold them accountable." Whether the Trump administration will continue to prosecute the action is unclear as of this writing. The servicer has publicly denied the allegations.

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